PRC 'Bear Stearns Moment': 1st Local Bond Default

Chinese businesses have acquired a reputation for being protected by the national or local government in the absence of true "market discipline." That is, they may even be chronic money losers, but they are continually fed cash infusions in the hope that they will eventually turn the corner. However, with new PRC policies coming in spelling the end to subsidized credit, energy and so forth, Beijing has decided to make Chinese firms face the rigors of domestic and international competition. Hence its first impending domestic commercial bond default.

It will come as a surprise to no one following international business that the casualty will be a solar panel maker. These manufacturers have been given generous government supports in the expectation that solar energy will be a growth market of the future. Unfortunately, this scenario has yet to pan out. What's more, the Chinese government is under pressure from the EU and US (among others) for allegedly dumping solar panels. To be sure, the Chinese have also made counter-challenges: following the back-and-forth legal wrangling gives me a frickin' headache.

At any rate, the stay of execution has not been forthcoming for Chaori--the first PRC victim in a solar bloodbath as price wars take their toll from Europe to Asia:

China's
first domestic bond default looked set to occur as expected on Friday
as there was no sign of a last-minute bailout for solar equipment
producer Chaori Solar, an event seen as a landmark for market discipline
in the world's second-largest economy.

The loss-making Shanghai Chaori Solar Energy Science and Technology Co Ltd (002506.SZ) warned this week it could only pay out less than five percent of the 89 million yuan ($14.5 million) in interest due on 1 billion yuan worth of bonds issued in 2012.

After
a series of near misses in recent years, in which local governments
stepped in at the last minute to rescue local champions, analysts say
the precedent-setting default is likely to force a re-pricing of credit
risk in a market that long assumed even high-yielding debt carried an
implicit state guarantee.

"The
Chaori default goes to show the government will begin to let the market
decide the fate of weak borrowers. This test case indicates the
government is addressing the moral hazard issue," said Christopher Lee,
managing director of corporate ratings for Greater China at Standard & Poor's in Hong Kong.

So, the implicit bailout has been rolled back. Chaori may be the first demonstration, but don't be surprised if others follow:

Such an adjustment appears
well-justified, as analysts expect more defaults on loans, bonds and
shadow-bank credit this year. Local governments and firms in industries
suffering from overcapacity are the focus of concern.

There is nothing wrong with borrowing per se--unless there is significant overcapacity in the borrowers' industries and (unwarranted) expectations that Uncle Mao will bail you out each time you get into trouble. For a lot of Chinese companies nowadays, both unfortunately hold. With some exaggeration, Bloombergsuggests this may be the "Bear Stearns moment" for Chinese credit, after which lenders become far warier:

This could be China’s “Bear Stearns moment,” strategists
at Bank of America Corp. said earlier this week, and may prompt
investors to reassess credit risks as they did after the
troubled U.S. lender was sold to JPMorgan Chase & Co. in March
of 2008. Six months later, Lehman Brothers Holdings Inc.
collapsed in the biggest bankruptcy in U.S. history.

“This will likely be the first of many defaults, although
I don’t think it’s going to cause a cascading effect in the bond
market,” said Brian Coulton, a global emerging-market
strategist in London at Legal & General Investment Management,
which manages some 450 billion pounds ($753 billion) globally.
“Short term, we’re likely to see higher bond yields but in the
long term, this will create a better market for pricing credit
risk.”

The yield on five-year AA- notes rose eight basis points to
7.77 percent on March 5, the most in almost four months. Yields
rose a further five basis points to 7.82 percent yesterday.
Ratings of AA- or below in China are equivalent to non-investment grades globally, according to Haitong Securities Co.